The Fallacy of Mega Cap Growth

Today we have a contribution from Ari Kuchinsky, who writes about the stock market, technology and often the intersection of the two.  Enjoy! - JB

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The Fallacy of Mega Cap Growth

 

Mega cap growth is an oxymoron. We currently have two "mega cap growth" stocks "“ Apple ($AAPL) and Google ($GOOG). Now we have Facebook coming to market with a valuation of $100 billion and it will be the third. The problem with "mega cap growth" is that the expectations will never meet reality because "mega cap growth" is not sustainable. For example, many people will buy Facebook because they believe it could be the next Apple, Google or Microsoft ($MSFT). AOL ($AOL), once valued at $240 billion and as ubiquitous as Facebook, is forgotten.

The problem with Facebook is that Google came to market with a valuation of $27 billion. So investors  quadrupled their money before Google crossed the $100 billion threshold. If Facebook becomes the next Google ($188B market cap), you only get a double. Is that enough upside potential to compensate the investor for the risks of buying an IPO? Google at $27 billion certainly had a much better risk-reward profile. Put another way, you won't get rich by buying Facebook. You won't see your $1,000 investment turn into $10,000 in 10 years. If you buy "mega cap growth," set realistic expectations. This isn't Microsoft going from a $500 million dollar market cap to a $400 billion dollar market cap in 15 years.

Apple investors suffer from the same fallacy. James Altucher believes Apple will be worth a trillion dollars and triple in value. With a $340 billion dollar market cap, a 25% increase in Apple means that its value has increased by the size of Amazon ($AMZN) or McDonalds ($MCD). This is not easy to do and impossible to sustain. Bullish Cross points out that Apple's P/E is contracting. The market can do the math. Even if Apple can meet its earnings projections for the next year, the climb higher will get tougher and tougher and the probability of meeting expectations goes down. Doubling $100 billion is much more difficult than doubling $1 billion. So while Apple owners may feel that the contraction of the earnings multiple is unfair, the market has spoken. It may feel unjust, but only price matters.

It is another reason why mega cap growth is a fallacy. Even if the company meets or exceeds expectations, the market will bet on the law of large numbers prevailing over the company sustaining growth. So while earnings may continue to grow, the multiple contracts and the stock price goes nowhere. And if your mega cap growth stock stops growing, it is a large fall from the top.

About Ari:

Ari has been watching stock prices since he bought one share of duPont in the fifth grade and has been a computer geek since he started visiting and running bulletin board systems (BBS) in the late 1980s. Professionally, Ari is a commercial real estate attorney in Austin, Texas and holds a law degree from Vanderbilt and a business degree from the University of Florida. The opinions expressed by Ari are in his personal capacity and are not associated with any other person or entity.

Follow Ari Kuchinsky on Twitter:  @arikuchinsky

 

 

Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Terms & Conditions page for a full disclaimer.

You might be interested in: Market Anthropology: A Currency Ugly Contest (thereformedbroker.com)People Forget Apple Is Now A Megacap (abnormalreturns.com)Stocks stage a huge rally (CNNMoney.com) View the discussion thread.blog comments powered by Disqus

The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.

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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.

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